Industry impacts of the Canadian dollar juggernaut both good and bad
Toronto, ON -- The Canadian dollar has skyrocketed an unprecedented 20% from January to the end of October in 2003,...
Toronto, ON — The Canadian dollar has skyrocketed an unprecedented 20% from January to the end of October in 2003, up from 63.5 U.S. cents in early January 2003 to above 76.0 cents in late October 2003. [Jan. 30, 2004 Update: After rising toward 79 U.S. cents in the first half of January 2004, the Canadian dollar was dropping toward 75 U.S. cents late in the month.]
The consulting firm Global Insight Inc. reflected the sharp rise in the dollar in its October 2003 forecast, expecting the currency to average 71 U.S. cents in 2003, 75 cents in 2004, and 80 cents by 2007. The currency’s appreciation and its forecasted advance raise urgent questions as to the impact on Canada’s industrial landscape.
While the Canadian dollar’s appreciation is dramatic, what is a surprise (relative to Global Insight’s forecast of late 2002) is the extent of the currency rebound, not the rebound itself. Late last year, the company anticipated a 6% appreciation in 2003, another 4% rise in 2005, to slightly above 70.0 U.S. cents, and then up to 72.4 cents in 2007. Anecdotal evidence suggests that many Canadian businesses have assumed a currency closer to 70 U.S. cents for planning purposes, rather than the historically low 64-cent value.
Price of U.S.-produced machinery and equipment will fall
This is going to moderate the negative impact of the stronger Canadian dollar on Canadian exporters, the research firm says. Another offset will come from the lower costs of imported inputs. Moreover, the price of U.S.-produced machinery and equipment will fall, making it cheaper for firms to invest in productivity-enhancing technology.
For the economy as a whole, weakness in the export sector will be offset by strength in the domestic, interest-rate sensitive sectors. This is because Global Insight has significantly lowered its interest rate forecast. On Oct. 31, 2003, Global Insight expected the three-month T-bill rate to average 3% in both 2003 and 2007, down 150 and more than 300 basis points, respectively, from what it forecasted late last year.
Because the level of economic activity is expected to remain roughly unchanged but the composition of monetary conditions (i.e., the combination of the exchange rate and the interest rates) will be very different, the composition of Canada’s economy will also be very different by 2007. There will be several clear winners and losers; some businesses will not be affected much, while many will fall in-between.
Clear winners and losers
The combined impact of the higher dollar and lower interest rates on industries is very complex and there are few hard and fast rules for categorizing industries into winners and losers. Residential construction and real estate services, however, can be expected to clearly benefit from the shift within monetary conditions. Both are highly interest-rate sensitive, domestically oriented, and do not face foreign competition. The high interest-rate sensitivity will boost their output in the environment of low interest rates. The domestic orientation will insulate them from the negative hit on competitiveness in foreign markets from the stronger currency. With few foreign companies snapping at their feet in Canada, they will not lose competitiveness in the domestic market either.
Industries that are export oriented, that face intense import competition in the Canadian market, and are not big users of imported inputs in the production process should be clear losers. There are only a few of those, as typically industries that are high on the export-orientation scale are also intensive users of imported inputs. The use of imports in the production process partly insulates a company from the dollar’s appreciation by lowering the cost of the imported inputs.
Businesses in the textile, clothing, and leather industry and in the miscellaneous category (which includes producers of medical equipment, jewellery, sporting goods, toys, and office supplies) appear the most exposed. Producers of machinery, computers, and transportation equipment are also vulnerable, since they export a large portion of their output and face a high degree of import competition. They are big users of imported inputs, however, which should help them deal with the stronger currency. In addition, low interest rates will lift domestic demand for their products.
The fact that an industry has not faced import competition in an environment of a weakening currency (i.e., through the 1990s) may be of little solace in the environment of a rising currency. Mining (including oil and gas), wood, and paper industries fall into this suspect category. All have a high export exposure, but faced little import competition in the 1990s. The complicating factor for the mining sector is that Canada is a price taker for most of the products, with very limited pricing power in nickel and natural gas markets. Consequently, an appreciation of the Canadian dollar relative to the U.S. dollar could, assuming no offsetting increase in U.S.-dollar commodity prices, lower the Canadian dollar price to a level below the profitability breakpoint. The alleviating factor for wood producers is that the boost to residential construction from low interest rates will raise domestic demand for their output.
Most service producers will neither gain nor lose from the strong dollar
Apart from wholesale trade and transportation and warehousing, the profits of service producers are minimally dependent on export sales, although businesses exclusively devoted to serving foreign tourists are clearly vulnerable. Services also face a low degree of import penetration in their domestic market. On the other hand, they will not benefit much from the high dollar via lower costs of imported inputs, as most of their inputs are from domestic sources. This is partly because most services are more labour intensive than goods-producing businesses. Labour inputs are not very mobile internationally, although businesses are becoming increasingly adept in sourcing labour from countries that offer low-cost and high-skill labour, such as India and Russia.
Potential boost for machinery & equipment
There are some exceptions, however. The higher dollar could still benefit several service-producing industries that spend relatively large sums on machinery and equipment, most of which is imported. Relative to value added, the education, truck transportation, telecommunications, and finance, insurance, and real estate industries spent a lot on machinery and equipment in the late 1990s. Assuming they continue to do so in the future, the higher dollar will help their bottom line by lowering their investment costs, thus possibly leading to productivity and output increases. Capital-intensive telecommunications and electric utility companies would also benefit from the lower interest rates, which could allow them to lower prices and thus generate greater demand for their products.
Global Insight Inc.’s Canadian Service provides clients with analysis, data, and forecasts for the Canadian economy and the individual provinces. Its clients use the Canadian Service to assess economic, financial and investment risk, as well as business opportunities. The Canadian Service Forecasting Team has won a KPMG award for forecast accuracy three times over the past decade. For more information, visit www.globalinsight.com.